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Budget Needs Micro Not Macro Focus

I have an op-ed in The Australian arguing that federal budget debates need a stronger micro rather than macro focus:

A good indicator of the macroeconomic importance of the budget is the reaction of financial markets on budget night. More often than not, the market reaction is minimal, highlighting the irrelevance of the change in the budget balance to economic growth and macro variables such as interest rates.

The real economic significance of the budget is its microeconomic implications: how tax and expenditure policies influence incentives to work, save and invest. Tax and spending policies should be evaluated based on the incentives they create, for better or worse.

As if to prove my point, Shadow Treasurer Joe Hockey has an op-ed on the same page arguing that the budget should be judged solely on the basis of the surplus.

Economic Papers has published the papers from the symposium on Monetary and Fiscal Policy Interactions: How to Improve Policy Outcomes held at the 2010 Conference of Economists. My contribution can be found here.

When the Guano Runs Out

A RBA research paper obtained through FOI advocates an offshore sovereign wealth fund, although the story seems to contain some editorialising by Paul Cleary, who thinks Australia is just a bigger version of Timor Leste. Liberal MP Paul Fletcher seems to think Australia is just a bigger version of Naru:

More fundamentally, natural resources are finite. When they run out, the money will stop flowing. So we should make sure we put some of the money aside – rather than spending it all now.

In our own region, the micro-state of Nauru offers a sobering example of the folly of assuming that the good times will last forever. It used to have large reserves of guano, used to make fertiliser. With only a few thousand people and a steady flow of mining royalties, it was in a fortunate position.

But the money was largely frittered away. Then the guano ran out – and Nauru had little to show for decades of mining.

Resources are not finite in any economically meaningful sense. The Coalition seems to think that SWFs are a great idea once government debt is paid off (they set up the Future Fund after all). I make the case against further use of SWFs in this op-ed. Governments that are not prepared to commit to binding fiscal responsibility legislation cannot be trusted with SWFs.

Sovereign Fiscal Responsibility Index

Australia is number one (meaning we hit the wall only after 40 years, as opposed to being broke right now). The United States sits between Italy and Hungary.

These are the variables:

Fiscal Space: An analysis of the additional amount of debt a country could issue before it is likely to face a fiscal crisis. Compares a country’s weighted-average debt level to the estimated maximum debt level a country could carry.

Fiscal Path: A projection of a country’s future levels of debt. The measure uses a projection of a country’s weighted-average debt level every year until 2050, using those figures to then calculate how long it takes a country to meet its maximum debt level.

Fiscal Governance: A rating of a country’s spending rules, transparency about fiscal policy making, and whether those rules are actually enforceable.

How Big Are Fiscal Multipliers?

An Independent Commission of Budget Integrity

The Business Council of Australia has included a report by Stephen Bartos making the case for an independent Commission of Budget Integrity in its pre-Budget submission to the government. Bartos references a similar proposal by Robert Carling and I on the subject, as well as earlier work by Nic Gruen, which drew on a 1996 proposal by Larry Ball when Larry was visiting the RBNZ.

The report does something we did not do, which is to cost the proposal. Bartos puts a 30-40 member commission with two executives and a board at $10m a year. To put this in perspective, it is less than the extra $15m the ABS wants to increase the frequency of the CPI from a quarterly to monthly release.

Sell the Gold Stock, Burn the Gold Bugs

Ed Truman makes the case for the US Treasury to follow the IMF and offload its gold stock:

the US Treasury holds 261.5 million fine troy ounces of gold. The government has been sitting on that gold since the Great Depression, receiving no return. At the current market price of $1,300 per ounce, the US gold stock is worth $340 billion. The Treasury secretary, with the approval of the president, has the power to sell (and buy) gold on terms that the secretary considers most beneficial to the public interest. Revenues from sales must be used to reduce the national debt.

If the United States were to sell its entire gold stock at the current market price, it would reduce the gross government debt by 2.25 percent of gross domestic product. Based on the average interest cost from 2005 to 2008, this reduction in debt would trim the budget deficit by $15 billion annually. Thus, the Obama administration would be doing something about the US fiscal debt and deficit without reducing near-term support for the ailing economy.

This would of course be incredibly lazy public policy, but should nonetheless give gold bugs pause. As I have noted previously, there is a certain irony in people who fear an over-supply of money taking refuge in an asset in which governments hold substantial stocks and for which the price is arguably in a stock rather than a flow equilibrium.

Peter Reith’s Triumph of Hope Over Experience

Robert Carling and I recently argued that a parliamentary budget office was the wrong model for an improved fiscal responsibility framework in Australia. Former federal minister Peter Reith has an op-ed in today’s Australian arguing for a PBO, but his review of overseas experience does not inspire confidence:

Hopefully, Australia’s PBO will not have the rocky start that the Canadians have had. Only recently, while I was in Canada, former deputy minister of finance Scott Clark wrote that the PBO had been an experiment in transparency and accessibility “that was doomed from the start”. Clark told me it was ironic that the Conservatives established the PBO in 2008, then undermined it from the start. The big problems have been a lack of independence, the failure to properly resource the PBO and the failure of government departments to provide necessary information. Clark says the PBO should be appointed and dismissed by parliament, not by the prime minister. It should be adequately resourced and have access to the same information as the auditor-general.

Carling and I have argued for an independent statutory Fiscal Commission, with Commissioners appointed in consultation with the states in much the same manner as the ACCC Commissioners. This was a theme I pursued at the recent Conference of Economist panel on Monetary and Fiscal Policy Interactions organised by Jan Libich from La Trobe University. The papers from the panel will appear in a future issue of Economic Papers.

Why the US CBO is the Wrong Model for Australia

Robert Carling and I have an op-ed in today’s Australian arguing that a parliamentary budget office modelled on the US Congressional Budget Office is the wrong model for reforming Australia’s fiscal policy framework.

I will be discussing these issues as part of a panel at this year’s Australian Conference of Economists on the topic of ‘Monetary-Fiscal Interactions: How to Improve Policy Outcomes.’ Other panellists include Don Brash (ex-RBNZ), Jacopo Cimadomo (ECB), Carl Wash (UCSC) and Jan Libich (La Trobe).

The Broken Windscreen Fallacy

When all is said and done, Cash for Clunkers was a deplorable exercise in budgetary wastefulness, asset destruction, environmental irrelevance, and economic idiocy. Other than that, it was a screaming success.

Fiscal Policy After the Election

Whichever side forms government, it will have to live with the legacy of the fiscal extravagance since October 2008. Just as present budgetary actions have implications for future economic activity, past actions have economic implications for the present and the near future.

Questions that will most likely arise during the term of the next government include the following: Why are long-term interest rates and the cost of obtaining funds from abroad continuing to rise? Why is private investment not improving as expected? Why is future economic growth now likely to be lower than otherwise? Why are inflationary pressures continuing to build?

The answer to each of these questions is the same. It’s either mostly, or partly, due to the excessive fiscal stimulus of the past two years.

My view is that activist fiscal policy in Australia and abroad will have negative consequences through a rather different channel: a negative wealth effect from increased government debt that will weigh on economic growth and consequently lower rather than raise long-term interest rates globally. I made this argument in a recent op-ed. Recent developments in global long-term interest rates have been consistent with this view.

For those interested, I will be discussing these issues as part of a panel at this year’s Australian Conference of Economists on the topic of ‘Monetary-Fiscal Interactions: How to Improve Policy Outcomes.’ Other panellists include Don Brash (ex-RBNZ), Jacopo Cimadomo (ECB), Carl Wash (UCSC) and Jan Libich (La Trobe).

Crowding Out and the BER

BUILDERS and architects tendering for work under Julia Gillard’s school stimulus program were told to include a “cost escalation” of up to 10 per cent to cover the expected inflationary impact of the scheme.

The hidden cost of the Building the Education Revolution, revealed in documents submitted to a Victorian parliamentary inquiry, suggests that as much as $250 million of taxpayers’ money could have been spent to cover a surge in building material and labour costs created by the state’s $2.5 billion share of the stimulus program.

Contract details provided by an architecture firm reveal it was required by the Victorian Education Department to provide a 7 per cent “contingency fee” and a 10 per cent “cost escalation” in the tenders it submitted for work on four primary schools in Melbourne’s east.

Government sources confirmed last night the department specifically included escalation costs in BER projects “because the stimulus was going to be a significant injection into the market/economy and prices could be expected to increase with greater levels of work being undertaken”.

Greg Mankiw versus Ken Henry on the Role of Economists in Public Policy

The following observation by Greg Mankiw could have been written in response to Ken Henry’s recent lament about the role of economists in public policy:

economists are social scientists, not politicians. And whether they work for the government or have the luxury of merely observing the scene from an ivory tower, the integrity of the profession and the importance of the work involved demand that they be subjected to critical judgment; they must be compelled always to submit their assumptions, data, models, and conclusions to careful scrutiny. The foremost job of economists is not to make the lives of politicians easier, but to think through problems, to examine all the available information about the problems’ causes and potential treatments, and to propose the solutions most likely to work.

This is a simple point, but one that is easy to forget. As Milton Friedman once put it: “The role of the economist in discussions of public policy seems to me to be to prescribe what should be done in light of what can be done, politics aside, and not to predict what is ‘politically feasible’ and then to recommend it.”

In a time of economic uncertainty and political turmoil, we economists — both in and out of government — could hardly do better than to follow Friedman’s sage advice.

An Unlikely RBA Research Discussion Paper

Imagine if you will the RBA publishing a Research Discussion Paper that reached the following conclusions:

despite a relatively stable total fiscal impulse the effectiveness of spending shocks in stimulating economic activity has decreased over time. Short-run spending multipliers increased until the late 1980s when they reached values above unity, but they started to decline afterwards to values closer to 0.5 in the current decade. Long-term multipliers show a more than two-fold decline since the 1980s. These results suggest that other components of aggregate demand are increasingly being crowded out by spending based fiscal expansions. In particular, the response of private consumption to government spending shocks has become substantially weaker over time.

rising government debt is the main reason for declining spending multipliers at longer horizons, and thus increasingly negative long-run consequences of fiscal expansions. We interpret this finding as an indication that further accumulating debt after a spending shock leads to rising concerns on the sustainability of public finances, such that agents may expect a larger fiscal consolidation in the future which depresses private demand and output. We also find that a stronger response of the short-term nominal interest rate goes along with declining spending multipliers. This result is consistent with an increasingly offsetting reaction of monetary policy to the expansionary fiscal shock.

The extract is from a European Central Bank Working Paper and the conclusions reached are in relation to the euro area. Don’t hold your breath waiting for the RBA to publish a similar study of activist fiscal policy in Australia.